October 17, 2017 / 2:07 AM / 10 months ago

Fitch Places LVGEM's 'B+' Ratings on Watch Negative

(The following statement was released by the rating agency) HONG KONG/SHANGHAI, October 16 (Fitch) Fitch Ratings has placed China-based LVGEM (China) Real Estate Investment Company Limited's 'B+' Long-Term Foreign-Currency Issuer Default Rating (IDR), senior unsecured rating and the rating on its outstanding USD225 million 8.5% senior notes due 2020, including that of the bond re-tap announced today, on Rating Watch Negative (RWN). The Recovery Rating is 'RR4'. The RWN reflects our expectation that LVGEM's leverage, as measured by net debt/adjusted inventory, will increase to over 45% from 2018 if it does not alter its business plan, following a planned HKD9 billion investment in a Hong Kong office building that the company announced on 11 October 2017. The acquisition falls outside the business plan the company had shared with Fitch and will lead to higher leverage over a sustained period if the company does not generate development sales from the building. Fitch will resolve the RWN upon the completion of the transaction, taking into consideration the company's financial profile after reviewing its revised business plan. KEY RATING DRIVERS Acquisition-Raised Leverage: Fitch expects LVGEM's leverage to increase to above 45% - a level above which Fitch would consider a downgrade - from 41% in 2016, if the office building it plans to acquire is held as an investment property. The construction of the office tower LVGEM plans to acquire, which is located in Hong Kong's Kwun Tong district in Kowloon city, will be completed by November 2019. Thus, the earliest this acquisition can contribute to company earnings is in 2020. The transaction is subject to the conditions precedent being fulfilled. The company expects to complete the transaction on 29 December 2017. Business Plan Review: Fitch will review LVGEM's business plan to assess the impact from the planned acquisition. LVGEM has the option to sell parts of the office building or cut back on further project acquisitions to manage its leverage. It can also manage its leverage through new shares issuance, as LVGEM has an existing mandate to issue new shares. The company's leverage will exceed 45% after it acquires the office building if it also pushes ahead with the development-property business plan it had previously shared with us. The terms and timing of LVGEM's other transactions, which are mostly injected from its controlling shareholder - Mr. Wong Hong King - will also affect its financial profile. Development Expansion Delays Deleveraging: Fitch expects LVGEM's leverage to continue gradually rising, as Mr. Wong is injecting several projects to help the company boost contracted sales. We expect LVGEM's contracted sales to increase above CNY10 billion from 2018, compared with less than CNY4 billion before 2016. The company's inventory mainly consists of completed development properties in Shenzhen, which will support its sales in 2017 and 2018. After that, it will rely on new projects - like its Liguang and Meijing urban redevelopments in Shenzhen - for further growth. LVGEM plans to obtain more urban redevelopment projects through asset injections in 2017-2019 from Mr. Wong, who has secured about 12 million square metres (sqm) of land, mainly in Shenzhen, Dongguan and Zhuhai - three major cities in China's Guangdong province. The Shenzhen project, which Fitch expects to have a gross floor area of about 4 million sqm, will be injected in 2018-2019 and is likely to become LVGEM's flagship urban redevelopment project. Quality Investment Properties: LVGEM's investment property portfolio includes the Shenzhen NEO complex, which has office and retail components, and three Zoll community retail centres in Shenzhen, one of which opened earlier this year. The Shenzhen NEO complex is located in the city's CBD and is almost fully occupied. Rents that were renewed in 2016 were re-contracted at 15% more on average compared with their previous rental rates. The two older Zoll centres had approximately 90% occupancy rates and positive rental reversion of more than 10% in 2016. The contribution from the planned Hong Kong office building will depend on the proportion of the building that is retained for rental. Deleveraging Plans Determine Rating: The RWN will be resolved when the transaction is completed. We will review LVGEM's business plan to consider the impact on its leverage and the sustainability of its property sales to derive the company's ratings. Possible outcomes if the transaction is completed are discussed below under Rating Sensitivities. DERIVATION SUMMARY LVGEM has a portfolio of quality investment properties, including its centrally located Shenzhen NEO tower office buildings, which enjoy near-full occupancy and double-digit positive rental reversion on renewal. Fitch assesses LVGEM's high-quality investment properties alone as having a business profile of around 'BB', with more than USD50 million in rental EBITDA per year and more than USD1.5 billion in rental-deriving assets. This is comparable with Lai Fung Holdings Limited's (BB-/Stable) USD60 million in recurring EBITDA and USD2.0 billion investment property value. LVGEM's recurring EBITDA/gross interest cover was around 0.6x in 2014-2016; setting it apart from most Chinese homebuilders that rely on more risky development-property sales to service their debts. However, Fitch expects recurring EBITDA/gross interest cover to deteriorate due to the company's expansion in the property-development segment. Fitch expects LVGEM's leverage of 41% in 2016 to increase to above 45% after 2018, following the acquisition of a Hong Kong office building and the injection of more urban development projects. This level is similar to other 'B' rated peers, such as Yida China Holdings Limited's (B/Positive) 46% and Hong Yang Group Company Limited's (B/Stable) 53%. Fitch may downgrade LVGEM's rating if its leverage exceeds 45% for a sustained period or the development of its for-sale property projects is delayed. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - The HKD9 billion acquisition will be funded with 60% debt and 40% from new equity and internal resources. - An injection of a large Shenzhen urban redevelopment project in 2018-2019, with LVGEM financing the consideration due to the controlling shareholder via equity issuance and shareholder loans. - LVGEM's contracted sales to reach CNY5 billion in 2017 and CNY10 billion in 2018. - The property-development segment's gross profit margin rising to 68% in 2017 and 65% in 2018, from 47% in 2016. - Recurring EBITDA to increase to above CNY400 million in 2017-2018, from CNY380 million in 2016. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Negative Rating Action. If the transaction is completed, Fitch may downgrade LVGEM's ratings, potentially by a notch, if its net debt/adjusted inventory exceeds 45% for a sustained period or the development of LVGEM's for-sale property projects is delayed. Developments that May, Individually or Collectively, Lead to Positive Rating Action. - If the transaction takes place, Fitch may affirm LVGEM's 'B+' rating with a Negative Outlook if net debt/adjusted inventory exceeds 45%, but there is a clear deleveraging plan to below that level in a short period. - If the transaction does not take place, the ratings may be affirmed with a Stable Outlook. LIQUIDITY Sufficient Liquidity for Acquisition: LVGEM will need to pay around HKD5.5 billion, or CNY4.6 billion, in 2017 out of the total consideration of HKD9 billion. The company's 1H17 available cash of CNY3 billion and its US-dollar bond issuance will provide sufficient liquidity to make this payment. LVGEM will also arrange secured offshore loan financing using this new Hong Kong office property as collateral. This, together with the company's other financing plans, will allow LVGEM to replenish sufficient liquidity to meet the operational needs of its development-property business. Contact: Primary Analyst Vicki Shen Director +852 2263 9918 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central Hong Kong Secondary Analyst Chloe He Associate Director +86 21 5097 3015 Committee Chairperson Su Aik Lim Senior Director +852 2263 9914 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Country-Specific Treatment of Recovery Ratings (pub. 18 Oct 2016) here Non-Financial Corporates Hybrids Treatment and Notching Criteria (pub. 27 Apr 2017) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Additional Disclosures Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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